UK labour market conditions are strong and inflationary pressures are heating up, a combination that has seen markets get excited about the prospect of a rate hike from the Bank of England (BoE), potentially before the year is out.
As seen in the chart below from Capital Economics, the implied market probability of a 25 basis point increase in the BoE’s bank rate jumped on Tuesday following the release of inflation data for August.
Core consumer price inflation (CPI) rose by 2.7% from a year earlier, well ahead of forecasts for an increase of 2.5%, leaving it at the highest level since December 2011. Headline annual inflation also accelerated, lifting from 2.6% in July to 2.9% in August, ahead of expectations for a smaller increase of 2.8%.
Both readings now sit uncomfortably above the BoE’s 2% inflation target, seeing the probability for a rate hike by May next year soar to over 60%. Some in markets think a rate hike will arrive even earlier, attaching a more than 30% likelihood that it will arrive before the year is out.
Andrew Wishart, economist at Capital Economics, says that while speculation over a rate hike this year looks premature, it’s likely that the Bank of England will begin to normalise policy in the first half of this year.
“We doubt that the current high rate of inflation will panic the MPC [monetary policy committee] into an earlier rate hike. Most members of the Committee want to see evidence of a pick-up in domestic cost pressures before voting for higher interest rates,” he says.
“With the labour market already very tight, and the economy set to strengthen in the second half of 2017 in our view, an acceleration in wage growth looks likely. And even if it fails to pick up steam, we think that the MPC will start to raise rates in the (June quarter) of next year.”
With speculation over a rate hike now intensifying, it lays the foundation for a blockbuster UK employment report that will be released later in today’s session.
In particular, markets will be scrutinising the average weekly earnings figures for any signs that tighter labour market conditions are leading to a lift in wage pressures.
Earnings are tipped to grow 2.3% from a year earlier in July, up from 2.1% in June. That would leave the annual figure at the highest level since March, and would mark the first back-to-back acceleration since late 2016.
The national unemployment rate is expected to remain steady at 4.4%.
Following the release of July’s jobs report, the Bank of England MPC are also scheduled to meet on Thursday.
Though no change is likely, a hotter-than-expected earnings figure, on top of the inflation data, would make for an interesting meeting.